That Perky German Consumer

by Claus Vistesen

Cross posted from Alpha Sources

In my recent notes on the outlook for the Eurozone economy I have emphasised that especially readings/indicators on domestic demand would be important for the ECB in terms of the justification to raise rates. As such, there is plenty of evidence to suggest that invesment and capex, particularly in Germany, might be slowly but surely heading down going further into 2007. Regarding indicators on domestic demand in Germany there is one out today in the form of GFK's consumer survey for July (i.e. a forecast) which is based on the questioning of 2000 people. Bloomberg, as always, have the headlines ...

German consumer confidence rose to a six-month high, led by an increased willingness among consumers to boost their spending.

GfK AG's confidence index for July, based on a survey of about 2,000 people, rose to 8.4 from 7.4 in June, the Nuremberg- based market-research company said today. Economists expected a reading of 7.8, according to the median of 25 forecasts in a Bloomberg News survey.

The improvement suggests consumer spending may increasingly contribute to economic expansion as investor and executive optimism wanes. Growth has so far been driven by exports and company investment. That has pushed the unemployment rate to a six-year low of 9.2 percent.

``The upward trend of the consumer sentiment will continue,'' GfK said in an e-mailed statement. ``A positive development on the labor market and therefore higher incomes mean that the best for domestic demand still lies ahead of us.''

Usually, I would hold here contenting with Bloomberg's summary which is also, I need to add, quite good. However, this time I gone a bit further and managed to dig out the 4 page press release itself from GFK (it wasn't that difficult really) to see whether in fact not the devil was in the detail. The main indicator is of course the sentiment itself and which is forecasted to rise from 7.4 to 8.4 points. Yet, this figure albeit the fact that it is set to show an increase is probably not to much use to any of us. More importantly I think is the propensity to consume as well as the income expectations amongst German consumers. Regarding the former the report notes a level at an all time high which of course, as a fundamental indicator, bodes well for domestic demand in Germany for the remainder of 2007. Yet, turning to the latter income expectations seems to have come off the very high level in the start of 2007 as it posted a decline in June. Whether this will continue is of course debatable. Given the general lucrative wage round negotiations in 2007 from the point of the employees income expectations are likely, I think, to remain strong throughout 2007 especially on a y-o-y basis. Should the trend continue to show a decline or perhaps a stagnation it is of course also important to note just how far the propensity to consume can go up whilst income expectations are declining. One thing I would like also to note is the complete and utter lack of economic reason which seems to be surrounding the 2007 VAT hike. Consequently, we get the following from the GFK and sadly this is also one of the bits quoted by Bloomberg ...

It is evident that the propensity to buy is benefiting from the effects of the positive income expectations, making the temporary blip caused by the VAT increase well and truly a thing of the past.

I am sorry but this just not make any sense at all and if only the world was so easy that you could raise taxes whose contractive impact on the economy would go away after one quarter. I will file this under on of those 'need to write about' for now but really; anyone with just the faintest idea of economics should be weary of accepting such claims. With this small niggle out of the way it is of course difficult not to be in a good mood on the back of this reading. Clearly, it is subject to notable cyclical fluctuations and can not be used to gauge long term trends (which BTW is why the remarks on the VAT are just, well; stupid!). Yet, sentiment remains increasingly on a high level amongst German consumers and contrary to business activity this seems to go on well into Q3 2007 after which the outlook, I believe, is much more uncertain. In terms of the immediate outlook for the Eurozone economy I also think that, if it was ever uncertain, an ECB hike to 4.25% is locked in at this point, unless the heavens somehow come crashing down on global markets or anything else of a cataclysmic event.

However and as customs prescribe it, I have saved the punchline for the end. As such, in this environment where everything seems to be right regarding the German consumer how much will private consumption grow? What in this environment of self-sustaining recovery is a good reading? Well, I will tell you; 1%!

The positive development of the job market and resultant improvement in earnings are mainly responsible for the fact that where domestic demand is concerned, the best is yet to come. All this supports the upward revision of the forecast for 2007 published by GfK last month, which predicts 1% growth in private consumption.

This I think is the big hidden secret about all this talk of a self-sustaining (i.e. domestic demand driven) recovery in Germany. In this way and although the news today is clearly and definitely on the positive side the long term picture remains the same. Quite frankly, and bearing in mind that the forecast presumably includes a Q1 drag on the back of the VAT hike 1% in a good year where growth, income, and confidence conditions seems to be both benigh and accomodative is just not enough. As such, what is the long term trend growth of personal consumption in Germany given its demographic trajectory? And what happens if global or perhaps European growth dynamics change even slightly for the worse?

Ok, this was a long rant and remember also that this is by and large a good reading which is also emphasised by the latest upward adjustment by the IFO institute of German GDP growth for 2007. Also it is worth noticing that the German government is seeing tax receipts grow at a healthy clip which is prompting the government to issue less debt in Q3 2007 something which is indeed good news given the long term trajectory of German public debt. In this light it is also debatable whether this can continue or put in other words; how far will this cycle continue?